Mortgage contracts include detailed, and sometimes, difficult-to-understand terms that are intended to provide borrowers and lenders with certain rights and responsibilities. Some of the terms in such contracts relate to what happens when a borrower wants to transfer a home with an outstanding mortgage to another party. Most lenders put clauses in place to prevent losses that could occur when borrowers transfer properties without their permission.
A due-on-sale clause protects a mortgage lender in the event that the borrower chooses to sell his home or transfer ownership of the property before paying off the mortgage. If the borrower sells his home before paying the mortgage lender in full, the lender would face a considerable risk. In the event that the borrower defaults, the lender might have extreme difficulty collecting the money due. A due-on-sale clause requires the borrower to pay the balance of the mortgage in full upon sale or transfer of ownership.
A due-on-sale clause can pose a problem if you want a new buyer to take over your loan payments -- a process often called assuming a mortgage -- rather than paying enough to cover the mortgage in full. This clause can also interfere with wrap-around mortgages, in which you -- the seller -- offer the home buyer a private loan and agree to remain responsible for the current mortgage. You would continue paying on the existing mortgage loan while the new buyer made loan payments to you, often at a rate higher than you pay for your existing mortgage. You could then pocket any down payment you require and use the new buyer's payments to pay your existing mortgage each month and provide income for you.
The consequences for violating a due-on-sale clause can prove dire. In the event that you sell or transfer your property without paying your mortgage off in full, a mortgage lender can foreclose, leaving both you and the new buyer without any remaining ownership in the property. Likewise, the foreclosure will be reported on your credit report, making it harder for you get another mortgage or other credit in the future.
Death and Divorce
Transfers that involve the death of a mortgage borrower do not usually involve a due-on-sale clause. The Garn-St. Germain Act of 1982 allows for due-on-sale exceptions in the case of death, divorce and seven other situations. Generally, an individual can inherit a property upon the death of a mortgage borrower without having to pay the mortgage in full right away. The same usually applies if you transfer a property to your spouse as part of a divorce settlement. However, this does not mean the new owner of the property gets away without paying the mortgage. The lender still has a right to payment and may require the new owner to assume the mortgage or obtain a new mortgage to pay off the balance owed.
While violating a due-on-sale clause does involve considerable risk, you might avoid a foreclosure in some situations. The bank has a choice of whether or not to use the due-on-sale clause to foreclose on a property. If you or the new buyer continue to make the mortgage payments on time, a lender might be less likely to foreclose, especially during troubling periods for the real estate market. However, there is no guarantee that keeping up with payments will encourage a lender to turn a blind eye.
- The Washington Post: When a Lender Is Restricted from Calling a Mortgage Due
- Bankrate: A Will Simplifies Bequeathing a House
- Bankruptcy Law Network: What Is a Due-on-Sale Clause?
- FoxBusiness.com: Dealing With Hubby's Mortgage After Death
- Cornell University Law School: 2 USC § 1701j–3 - Preemption of Due-on-Sale Prohibitions
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